Back to the future of P2P Lending, we interview one of those peers

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The founding idea of both Lending Club and Prosper was Peer To Peer (P2P) Lending. Along the way, professional intermediaries aka Institutions got into the act and we started referring to Market Place Lending or Altfi. P2P Lending means no other intermediaries – just Lender + Borrower + Platform. The imperative to scale fast, to keep equity investors happy, forced the platforms to get capital from professional intermediaries. Something was lost in this transition. Professional intermediaries add fees and also tend to be less loyal as they see their job as moving money around fast to protect their investors. 

Hector Nunez is a good example of those original P2P retail investors. He has been investing in notes on Prosper since the early days. In an ironic twist that tells a lot about Fintech in the capital markets, Hector also has a job as a doorman at 75 Wall Street in New York City, which used to house trading rooms and now has been turned into apartments (in the new FiDi or Financial District of Manhattan). Hector was one of the early investors in Prosper loan notes and turned his $5k original stake into $138k over 10 years. This is a track record that most professionals would envy. See later for how this translates to IRR.

So it made sense to get Hector’s take on some of the big shifts in this market.

What is the difference between retail and institutional investors?

Our thesis is that three things separate the retail investor from the institutional/professional investor:

  1. Access to tools, techniques and data. Fintech is democratizing the tools, techniques and data that used to only be available to professional intermediaries. This is a work in process. Some tools are still only available to professional intermediaries, simply due to how they are priced, but this will change as new players come into the market. Techniques can come from books, blogs, forums and online courses. Platforms give access to data to encourage investors. So it is only tools that are lacking and entrepreneurs who build these tools know that this is primarily a pricing decision and that selling to 100 retail investors at 1c is the same as selling to one Institution for $1 and may be easier. We asked Hector about some of these tools.
  1. OPM (Other People’s Money). Institutions invest OPM. Retail investors invest their own money. To invest well you have to be a) contrarian and b) right. It is hard to be contrarian when you invest OPM – you have explanation risk. Retail investors have no explanation risk. When they are contrarian and wrong, they only have to explain it to the mirror and learn from why they lost.
  1. Concentration. One Institution can lend a lot of money and that is a quicker way to scale a platform than persuading lots of retail investors to use the platform. One retail investor might be able to deploy $300k while an Institution can easily do 100x that i.e $30m (but that $30m can also disappear equally fast as Institutions tend to be more trigger-happy). Getting 100 retail investors to deploy $300k or 1,000 to deploy $30k certainly takes longer, but it gives the platforms more long-term capital. One way to think about the retail investor is like a bank depositor who takes more risk and does more work for a much higher return.

Hector explains how he invests

I asked Hector to explain his investing approach:

Prosper gives borrowers credit grades (“AA,” “A,” “B,” “C,” “D,” “E” and “HR”) in which the investor sees and gets to invest in the loan the way she/he sees fit. In my case, I’m investing in only 2 grades (“B” and “E”). I have other grades but those are the ones that are in beta mode or that I ceased to invest in. Because there are only 3 or 5 years terms, it takes that long to purge the grades that I’m no longer interested in investing. Now one can argue that this is the disadvantage in retail P2P lending in that once something goes wrong, there’s no essential bail out. I would argue that this is actually beneficial because it teaches me to stay away from certain kind of loans with certain kind of attributes. As opposed to “jumping ship” early and probably not learning exactly why the loan went south. So I set a fixed amount of notes in 3 credit grades that I’m going to invest in and that number is 200. diversification is key and that by having 100 loans (notes), the investor is almost guaranteed to have a gain.

Agile Investing and IRR

Institutional/professional investors focus on IRR (Internal Rate of Return). It is a metric that shows performance. Hector, like most retail investors, does not obsess about IRR because he is not selling to investors.

What Hector is doing – and other retail investors work in a similar way – is what I call agile investing. Like agile programming, you start small and add more and refine the approach as you get market feedback (what you win and what you lose).

In Hector’s words:

Here’s what I started with: 5K which 10 years later (this upcoming March) is currently @ ~$138K. Please note that this includes both my trial and error loans as well as my lower interest loans. I started with 5K, then I put in an additional 10K, then 15K, another 30K and then another $20K. Throughout this process I’ve taken out then put some funds back in so overall, my principle is ~$80K and the rest is in excess of principle.

If Hector was running a Fund and pitching OPM for money, he would track all of those inputs and outputs to calculate IRR. That is how intermediaries work and IRR is a useful tool. However, what Hector is describing is how individual investors work which is to experiment and put more into what works. This is what I call “agile investing”. Note that “individual investors” could mean people with a lot of money to invest – think of Family Offices and Prop Traders.  So this maybe the new mode of investing that the micro asset managers use (see later for follow/copy/mirror model investing).

Ceiling?

I asked Hector what kind of “ceiling” he sees for this way of investing.

I cap off 200 loans for each grade that I’m investing, because I believe there is a point where too much diversity negates gains and losses. Also, years ago, Prosper imposed a percentage limit on both retail and institutional investors which affects the monetary amount that I could invest in. Currently it is @ 10% for the 1st 24 hours. In other words, when a borrower posts his/her loan on Prosper, any investor could only contribute (invest) to 10% of the borrower’s total loan within the 1st 24 hours of the borrower’s loan. After that, the cap is lifted and the investor could invest any monetary amount. I only invest to the 10% limit so monetary wise I’m also capped. So my overall monetary ceiling is currently @ ~$400K and my overall note ceiling is currently @ a little over 500 which includes my beta loans. Once, I reach those goals, I will then have to branch out into other platforms i.e Folio and apply my tried tested and proven strategy on that platform.

Hold to maturity or trade on secondary market?

Prosper announced in September 2016 that they were Closing Down Their Secondary Market for Retail Investors. Prosper had been running a secondary market via FOLIOfn since 2009.

This is the sort of tool that Institutions have taken for granted for a long time.

The old fashioned idea of a bond was to hold it to maturity, collecting interest along the way and many Institutions still like to work this way.

I asked Hector for his take on this:

“Personally I’m not affected by this move as I never had plans on selling my notes on Folio. Remember, we had Folio as an option to sell and I knew it and I never bothered to look at Folio to sell my notes. And in that aspect, I believe I was a typical investor and part of the reason why I think Prosper and Folio parted ways. Remember, if loans default, there’s still a chance we can recoup our losses via the collection agency which work on our behalf (as opposed to losses in the stock where there is no chance of recouping). With Prosper there’s a chance that the collection agency can recoup some if not all your principal with the interest (all for a small fee of course which the agency automatically takes from the funds recovered). I did create a Folio account but that was as a security blanket which I would have put in use had the majority of my investment soured. As the story went, it never did.”

Cross platform investing

Institutional investors are strong on diversification. Hector agrees, but has a slightly different take:

“I believe in that old cliche that you should not put too many eggs in one basket. I am all about cross platform investing. Should one platform go south, you have another to pick you right up; however I only believe that to a point. My belief is that too many investments would cancel themselves out leaving the investor with little financial movement either way (gain or loss).”

Hector is referring is what Institutional Investors call “closet indexing”, when investors diversify so much that the end result is very close to an index (which you can buy for very little from somebody like Vanguard).

One way to diversify is to go global. I asked Hector whether he would consider investing outside America, via platforms in those countries. Hector was clear on this front and his logic was interesting:

No and as of now I don’t have any plans on doing so. There are a couple of reasons why. First, I must complete my investment goal on Prosper before I step on to a new Market. I will make an exception with Folio because I already have an account and I’ve been doing my research with them for quite some time. Second, I trust the American market more than international markets because I feel that I have a better pulse on the US market than that of another country. Probably this is because I live in the US. My strategy relies much on understanding their personal financial background in the context of some event that makes them need a loan. Example: A person could be asking for a loan because he/she may have psychological issues and need their medical expenses paid off and the borrower has a pretty decent financial history while another person may be asking for a loan for a vacation and have a questionable financial history. I would lend to the person in medical need not because of what the borrower is going to use my funds for but rather because of their proven financial track history.

Hector ends with what all good investors have – humility and a learn it all attitude rather than a know it all attitude:

Believe it or not I’m still learning on Prosper and still letting my “beta” notes play.

Can I follow/copy/mirror Hector?

One theme that we have been exploring on Daily Fintech is the emergence of Micro Asset Managers enabled by the follow/copy/mirror model:

  • Copy and mirror trading platforms like eToro, Zulu Trade, Darwinex.
  • Thematic investing marketplaces that allow new micro-managers to emerge by creating their own financial product (equity based), and actively manage it; like Motif Investing, and Wikifolios.
  • Even social research platforms like StockTwits are stepping into this space by offering Follow functions and rankings of the subscriber micro-managers.

This is an alternative to either passive low cost index tracking or high cost active hedge funds. The idea is simply to follow/copy/mirror an investor who is investing their own money. This allows a passive investor (who does not want to work hard at the investing game) to follow/copy/mirror the active investor (somebody like Hector) who gets some share of the upside. That active investor does not need to gather or manage investor’s assets, so they do not need to charge an AUM fee. This is a game-changer in the massive asset management business.

Hector was eloquent that IRR % was more important than total funds under management:

I believe that the amount of money one has in investment is not the sign or bar of performance rather it is the rate of return. A person can have a million dollars in stocks and come out at years end with 1.1 million and another investor could have 100K and turn a profit of $20k and it is the latter investor that I would be most impressed with and try to emulate.

The follow/copy/mirror model is working today in VC (Angel List) and in Public Equities and in FX, but I am not aware of anybody doing it in Fixed Income/Lending. Hector is the sort of investor I would like to follow/copy/mirror. I asked Hector for his take on this:

I welcome you and any potential retail Prosper investor to follow my lead. I could give you or anyone nice fundamental tips in getting started as well as giving you warnings and recommendations. If you or anyone wishes to get started, please let me know.

It will be interesting to see if the Lending platforms start to offer this or if some other platform specific to the follow/copy/mirror model offer a cross-platform capability.

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What does the Credify story tell us about Market Place Lending and $LC stock?

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This story broke on Wednesday 15 November. 

The story is that the founder of Lending Club, Renaud Leplanche, who was ousted in a scandal in May was creating a new venture to compete with Lending Club called Credify. Headlines talked about 2nd Act or Comeback.

The story came out in the Wall Street Journal (WSJ)  and appeared to be good old-fashioned journalism – digging around for a scoop by looking at corporate filings.

I do not think there is much of a story about Credify itself. The chances of success for that venture are slim (more on that later). The story hangs on 3 threads:

– What does this tell us about the state of online journalism?

– Does this justify selling Lending Club stock?

– What does this story tell us about the transformation of consumer lending

What does this tell us about the state of online journalism?

News drives markets and digitization is changing news, so this is indirectly a Fintech story.

As a media entrepreneur this aspect of the story interests me.

This was either a non-story done under time pressure that had a big impact or an old-fashioned scoop from hard core investigative journalism. The latter is to be celebrated because the economics of digital media don’t allow much budget for hard core investigative journalism. Imagine All The Presidents Men today.

The time pressure on journalists today is intense, because the online ad model post search, social and adblockers, does not allow time for hard core investigative journalism.

There is no site for Credify (various spellings and .tld urls end up in a blind alley) and nobody is talking on the record. Let’s assume the story is true. It certainly appears that a company called Credify was created by Renaud Leplanche. Without a famous name impacting a public stock, this event would have gone unnoticed – just one out of 1,000,000 new businesses created each year in America alone.

So I incline to this being a non-story done under time pressure. Of course, only time will tell and events may prove me wrong. Credify may launch and quickly get to the $50m in revenues mentioned in the WSJ article as the target for 2017.

A non-story done under time pressure unsettles markets because, if it comes from an authoritative source such as WSJ, other publications repeat the story citing the original post as evidence. That is what happened in the Credify story, which was briefly on the technology front page (Techmeme).

Does this justify selling Lending Club stock?

No.

$LC stock did decline a bit the day after on the 16th and by more than 5% a day later on the 17th and a bit more on the 18th. Over $125m of market value evaporated. Nobody knows for sure why a stock moves – in this case there were also options expiring, the stock had gone up sharply and may have needed a correction, there was a negative post on Zero Hedge (do they have positive posts?) and a story about Lending Tree that defined them as competitors (incorrectly in my view).

Disclosure; I bought LC stock after the May crash (got in at 3.51). That is why I was paying attention to the Credify story. My investing approach is to do a lot of fundamental analysis before buying so that I have context to look at news as it comes in and make a Buy/Sell/Hold decision. This story was a Hold decision – it was “noise on the line”.

Reactions of retail traders on stock forums mostly also did not think that the story was significant. This was a sample reaction:

“Not sure why Laplanche startup would be more concerning than Goldman’s market entry.”

Which brings us to the final part of this story.

What does this story tell us about the transformation of consumer lending?

Lending Club is the bellwether of MarketPlace Lending. It may well be bellwether of the whole Fintech market. If Lending Club fails, investors will tell Fintech entrepreneurs “stop trying to compete with banks, go back to the old model of selling software to banks”.

I am calling this market the transformation of consumer lending, because so many of the names don’t quite fit any more:

– P2P Lending. This is what it was called when early visionaries such as Renaud Leplanche were getting started about 7 years ago. Individual lends to individual via the platform – beautifully simple and revolutionary concept. Whatever else Renaud Leplanche does with his life, the world owes him a debt of gratitude for making that work.

– Market Place Lending. This name evolved when fast moving credit hedge funds and other institutional lenders in moved in. Now the value chain got longer. Individual lends to Institution which lends to individual via the platform.

– AltFi. In this iteration, the market place disappears. The credit hedge fund buys or builds the digital loan origination technology so that they can lend directly to individuals from their own balance sheet. This is also sometimes called balance sheet market place lenders. There are also hybrid models with some balance sheet lending and some market place lending.  Examples include Avant and SOFI.

– Digital Lending. In this iteration, the credit hedge fund disappears. Banks buy or build the digital loan origination technology so that they can lend directly to individuals from their own balance sheet. As Banks have a lower cost of capital they can beat the credit hedge fund. First out of the gate is Goldman Sachs with Marcus. They will beat the AltFi Lenders because of lower cost of capital.

Consumer Lending is such a massive market and we are still in the early days, but it is an utterly different market from when Renaud Leplanche was doing his pioneering work in the founding days of Lending Club.

One thing that gives me confidence in Lending Club (and Prosper but they are still private so I cannot buy their stock) is that the original P2P Lenders are still there. They may only be one lender, along with Banks and other Institutions, but they are still there. The humble retail lender has confidence because they get good risk adjusted returns compared to any other credit avenue (if they are careful). That confidence gives me confidence as an equity investor.

There is some news that would prompt me to sell LC stock. If the new CEO was also caught doing something wrong my take would be “once means nothing, twice is coincidence and three times is a trend and I am not waiting around for the third time”. The Lending Club Board proved in May that they are vigilant and decisive, so I think this is unlikely.

Fintech is fundamentally about the democratization of technology. Given the right tools, smarts and hard work, a retail lender can do what a credit hedge fund does. There has never been a shortage of people with smarts and hard work. Now they are also getting the tools. That is the revolutionary promise of Fintech in a nutshell.

Given that analysis, what would a smart entrepreneur who knows consumer lending do today:

– P2P Lending. Building consumer trust and network effects is a long game and the consumer lending market is no longer in the nascent phase that rewards a long game.

– Market Place Lending. Building Institutional trust takes time. The May scandal that led to Laplanche being fired broke that trust. This would be a hard sell.

– AltFi. This was a good play a few years ago, but with Banks like Goldmans getting into the game, this would be highly risky today.

– Digital Lending. Only an option if you are a licensed deposit taking bank.

That analysis told me that it was not time to sell LC stock and that the next iteration of this market is back to the original P2P Lending model of empowering retail lenders on a mass scale.

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Daily Fintech Advisers provides strategic consulting to organizations with business and investment interests in Fintech & operates the Fintech Genome P2P Knowledge platform.

Market Place Lending is simply automated Asset Liability Management and that is a big deal. 

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Eons ago I managed a sales team that sold core banking systems to global banks. One sales guy was consistently the best performer. I decided to find out his secret to teach it to the rest of the sales team. 

He had found a report that senior managers really wanted and that was easy to create in our system and that was hard to create for our competitors. He had senior management attention and a moat against competition – simple and brilliant.

The report related to Asset Liability Management. So I took a crash course to understand the rather dry subject of Asset Liability Management (ALM). Despite being a dry (read boring) subject, it is key to banking. In short, a bank with good ALM has very low risk and makes good profit and vice versa. 

Asset Liability Management 101

ALM is simply matching the Bank’s Deposits (aka what a bank borrowers from Consumers aka a Liability as seen on the Bank’s balance sheet) with with their Loans (aka what a Bank Lends to a consumer or other entity aka an Asset as seen on the Bank’s balance sheet). If Assets and Liabilities get out of alignment, the Bank has high risk. For example if a Bank gets Deposits on a 3 Month Term and Lends them on a 3 Year Term, something could go badly wrong. 

Of course, if Banks can borrow on a 3 Month Term and Lend on a 3 Year Term, everything is peachy until too many Consumers ask for their money back at the same time. When that happens it is called a “run on the bank” or systemic risk; Governments and their taxpayers are signaling that they don’t like spending taxpayers money to bail out banks when that happens.

A bank with good ALM poses no systemic risk. 

Which brings us to Market Place Lending. People have pointed out that Market Place Lenders don’t pose systemic risk. If a borrower has a 3 year term then the Lender has to have a 3 year term; they have to match or the transaction does not close.

Market Place Lending has perfect ALM.

When you look at Market Place Lending in those terms you can see how powerful it is. In the original P2P Lending model Consumer A Borrows and Consumer B Lends. The marketplace simply matches them. There cannot be any ALM mismatch. If the Borrower wants a 3 Year Term, the Lender has to accept a 3 Year Term or decline the transaction. 

As the Market Place Lending market grew, intermediaries such as Banks and Hedge Funds jumped into the Transaction. Now the value chain is Consumer A Lends to a Bank or Hedge Fund who then lends to Consumer B. Of course in our complex Financial System that chain can be longer – Consumer A Lends to Insurance or Pension Fund who lends to Bank or Hedge Fund who then lends to Consumer B. However, as long and complex as that value chain gets, it is still Consumer A lending to Consumer B.

The problem for all the intermediaries in that value chain is when Consumer A and Consumer B figure that out at scale. 

“My excess cash flow goes straight to my deposit account”

That is an actual comment from a Pensioner who is living well within his means. He has an old fashioned Defined Benefits Pension that is inflation adjusted. He earns more than he needs to spend.  

 This is enabled by a  Sweep Account – well known to anybody who uses Banks prudently. That Pensioner has his bank automatically transfer money from his “Current Account” to his Deposit Account. (The Pensioner was British, if he was American he would have referred to his “Checking Account”). He knew he was getting a lousy deal on that Deposit Account, but did not fancy the hard work of figuring out how to make good risk adjusted loans via a Market Place Lending platform.

Post PSD2, a Fintech startup could sweep that into a Lending Account based on risk/return profile. That is is the sort of “take something complex and make it easy and intuitive with some UX magic” that digital startups excel at. The prize is big. It could be one of the Deposit Innovators that we profiled back in July who seizes this prize. Or an existing Market Place Lender. This is still a nascent wide open opportunity.

Sweep Accounts into Market Place Lending could eliminate the cost of funds advantage that banks have today and that is a really big deal.

To see the real spread enjoyed by Banks, look at this analysis on Nerd Wallet of the best term deposit rates and then contrast that with the Average Net Annualized Returns on Lending Club.

Dear Mr Treasurer, how much do you love your ZIRP and NIRP?

The first to break the dam might be Corporate Treasurers. Like the Pensioner, they know that they are getting a lousy deal on Bank Deposits. Unlike the Pensioner, they have the resources to do something about it. Corporate Treasurers are already doing something about it by lending to their vendors through Supply Chain Finance (SCF). When SCF connects with MPL, the change will come very fast.

Today Corporate Treasurers use sweep accounts to get excess cash into Money Market investments, such as repurchase agreements or commercial paper. SCF is another short-duration investment. However Corporates have excess cash that they don’t need for longer durations so could easily Lend to Consumers or Small Biz for a 1,2, or 3 year terms. 

That is why we believe that Market Place Lending is still in its infancy and will fundamentally change the world and why Lending Club could the Priceline of Fintech. (Disclosure I was fortunate enough to buy Lending Club stock at 3.51).

 Daily Fintech Advisers provides strategic consulting to organizations with business and investment interests in Fintech & operates the Fintech Genome P2P Knowledge platform.

Which Chinese Market Place Lenders will emerge from consolidation?

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This is part 2 of our research into Chinese Market Place Lenders. Part 1 is here.

Ppdai is credited with being the first MPL (then called P2P Lending) in China, following close behind pioneers in UK and USA. Since then, literally thousands of platforms emerged. This is clearly unsustainable. Market Place Lending is a networks effects business. More borrowers lead to more lenders and vice versa. So the thousands of MPL platforms in China has to come down to a handful of companies.

Top of the Pops

The top 20 platforms as tracked by Wangdaizhijia and reported by Lendit are:

1 Hongling Capital
2 Lufax
3 PPmoney
4 Wzdai
5 Weidai
6 Xinhehui
7 Yooli
8 Jimubox
9 Jinxin99
10 Renrendai
11 Srong
12 Yirendai
13 Xiangshang360
14 Edai
15 Niwodai
16 Touna.cn
17 Eloancn
18 Qianbaba
19 Itouzi
20 Tuandai

Source: Wangdaizhijia

The only names that resonate in the West are Yirendai (because they did an IPO in America) and Lufax (because they are publicly mulling an IPO in Hong Kong). Lufax is being valued almost 10x Yirendai and ranks second place vs 12th for Yirendai. So Yirendau could be like Ondeck vs Lending Club, first out of the IPO gate but small compared the market leader and it may be acquisition bait during the consolidation phase.

The IPO process for Lufax may bring a) capital b) more mature processes (due to public scrutiny) and c) consumer name recognition. For the latter, the Hong Kong venue for Lufax makes the most sense.

Here are the top 3 ranked by Transaction Volume:

Company Transaction Vol No. of borrowers  
 
Hongling Capital 300,401 3,944  
 
Lufax 137,250 24,984  
 
PPmoney 130,909 5,506  
 

Here are the top 3 ranked by No of Borrowers:

Company Transaction Vol No. of borrowers  
 
Xiangshang360 46,872 30,497  
 
Luffa 137,250 24,984  
 
Weidai 83,250 11,550  
 

(Yirendai is 4th).

Note LUFAX in second place on both scores. If their IPO in Hong Kong goes well, they look like a strong contender.

What role will BAT (Baidu Alibaba TenCent) play?

These are behemoths by any definition. In simple market cap terms (rounded to nearest $ billion as of Oct 2016):

Baidu = 61

Alibaba = 263

TenCent = 258

In comparison Lending Club = 2 and Lufax (pending IPO) = 18.

How much these giants want to get into Lending is the key question. All three have launched online banks, with Baidu the most recent into the game.

So, we can expect plenty of excitement as the MPL market in China matures.

Daily Fintech Advisers provides strategic consulting to organizations with business and investment interests in Fintech & operates the Fintech Genome P2P Knowledge platform.

The big and scary prize – Marketplace Lending in China

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This is a two part investigation. Part two will be on Friday.

Big: a big and fast growing middle class and a banking sector that has been asleep at the switch on the consumer side; the idea of China as a consumer market is relatively new and Chinese banks are not known for being agile. Imagine the American market without Wells Fargo, JP Morgan Chase and Citi as competitors. According to Citi, 96% of e-commerce sales in China are done without a bank’s involvement.

Scary: just ask Travis Kalanick of Uber; the most full-steam ahead damn the torpedoes entrepreneur was beaten by Didi in China. His retreat will probably be a hugely profitable deal (like Yahoo and Alibaba) but it is still a retreat. It is really tough to compete in China. So, scary for Western firms. For Chinese firms, scary if you have to compete with BAT (Baidu Alibaba Tencent).

To understand where this puck is headed, we seek answers to the following 5 questions:

Will China MPL follow the Uber Didi trajectory?

How will global lenders get in on the action?

How is the progress from Wild West to Settler phase?

In Part 2:

Which Chinese Marketplace Lenders will emerge from consolidation?

What role will BAT (Baidu Alibaba TenCent) play?

Will China MPL follow the Uber Didi trajectory?

Trajectory: big Western firm spends a lot of money to get into the market and eventually cedes victory to a Chinese competitor and before retreating gets a big shareholding in the competitor that beat them.

You could argue either case:

Yes: look at the tribulations of other Western Internet firms in China. Google lost as did Facebook and Uber.

No: China has a lot at stake. If they have to trade off lower interest rates for consumers (benefitting hundreds of millions of Chinese) vs protecting a local firm, it will be a tough decision. Also, it is unclear why Didi beat Uber. Was this a level playing field where “the best man won” like on an English boarding school rugby pitch? Or was the referee biased to the local team? Baidu almost certainly won because the Chinese government wanted a search firm that was friendly to their interests. It is not clear if that is why Tencent won in messaging or why Didi won in car sharing. If it is a level playing field, a great Western entrepreneur can hire a great Chinese team to localise properly and can still win.

Western MPL has not yet made a serious crack at the China market; if you never attack you don’t need to retreat. It is hard to imagine the shareholders of Lending Club or Prosper backing a super expensive high risk entry into China – not after Uber got their head handed to them.

So, China MPL will NOT follow the Uber Didi trajectory, because that story will prevent any Western MPL from trying. The Uber Didi story has entrenched the view that you cannot win in China.

How will global lenders get in on the action?

China has a very high savings rate (30%), so local banks should have plenty of cash but most do not have the systems and processes to do consumer lending profitably at scale. So there is a window of opportunity for global lenders to get in on the action. They will do so when the Sherriff cleans out the bandits (see next section).

As the MPL market matures globally, we expect to see more platforms that allow a retail lender anywhere to choose which geographic market they want to lend into; for example, when a Chinese consumer can lend to a Swiss consumer and vice versa, MPL will have gone global and mainstream.

For example, Mintos connects investors with non-bank lenders from mutliple European countries.

Many consumer lenders tend to stick to their local market; over time we expect more will go where the risk adjusted returns are best – even if it looks “foreign” at first. For example, lending money at 26% on the P2P Lithuanian platform that shows us 4% default rates may look too exotic, but some savvy investors have already found this to be attractive.

We expect to see more of this cross border lending because MPL platform are competing with each other, margins narrowing and one avenue of growth will be by moving into other countries. There are still a lot of tax related issues that are unclear.

Most unclear is whether China will welcome cross border lending. This news about Yirendai’s parent Credit Ease investing in Prosper and Avant loans indicates financing flowing one way.

How is the progress from Wild West to Settler phase?

MPL in China is in the Wild West phase, with hundreds of marketplaces and lots of scams and very crude, violent debt collection practices. We know how this movie ends – the Sherriff rounds up the bad guys and the settlers move in and we get towns and cities and the big money is made.

Some progress is being made, some of it from the free market and some of it from the government.

“For thousands of years, debt collection in China has been a mafia business,” said Wen Yong, chief executive of Shenzhen-based ZZG360 (ZZG stands for Zhai Zong Guan which translates to “debt explorer”. ZZG360 list problem loans on MPL platforms and provide that data to debt collectors, which must agree to use legal, non-violent methods when recovering it.

The Government Regulators are also stepping up to the plate; the Sherriff has posted the new rules. Crowdfund Insider has a good report on the 12 commandments laid down in December 2015 by the China Banking Regulatory Commission (“CBRC”). Thou shalt not (my comments in italics):

  1. Use the platform for self-financing or for financing of related parties. (This stops the most egregious scams).
  2. Directly or indirectly accept and manage lender funds. (This is interesting. It prevents what in the West has become called Balance Sheet Alt Fi Lenders and it is unclear if that is a bad thing).
  3. Provide guarantees to lenders or promise guaranteed returns on principal and interest.
  4. Market or recommend loan investments to users that have not completed identification verification after registering on the platform
  5. Directly make loans to borrowers, unless stated otherwise by applicable laws and regulations
  6. Structure loans into investment products with liquidity timing that differs from the original loan term (“thou shalt not have have Asset Liability Mismatch” is another way of saying “thou shalt not have systemic risk”).
  7. Sell bank wealth management products, mutual funds, insurance annuities and other financial products (Hmm, so MPL can only be an exchange, China is banning the 20th century strategy of vertical integration).
  8. Unless stated otherwise by applicable laws and regulations, collaborate with other investment or brokerage businesses to bundle, sell or broker investment products (sounds like the sort of grey area that would make fortunes for lawyers and/or those with good connections).
  9. Provide false loan information or create unrealistic return expectations.
  10. Facilitate loans for the purpose of making investments in the stock market. (No borrower would offer this as a reason to get a loan, so this sounds like the Casablanca scene “I am shocked. Shocked!! to find that there is gambling going on”).
  11. Provide equity crowdfunding or project crowdfunding platform services. (Separation of asset classes by statute sounds like a hindrance to innovation).
  12. Other activities forbidden by applicable laws and regulations (legal catch all phrase).

This is a market without FICO that may invent a better alternative to FICO. That seems to be what ZZG360 is aiming for. The company is growing fast – with around 59 debt collection agencies and Rmb1.3bn ($195m) in debt on its platform. Like FICO, ZZG360 does not buy or sell debt. So it is not regulated, but by shining a data light on an opaque business it is part of the move from wild west to settler phase.

This clean-up phase also involves trading bad debt via online platforms. Companies with too much debt can sell unpaid accounts receivables or assets held as collateral in order to clean up their balance sheet. The banks have an unsustainable level of Non Performing Loans (NPL is officially 1.75%, but some analysts put the real figure as high as 15%). Internet Finance (the Chinese name for Fintech) may sort out this problem before the banks do.

On Friday, our investigation turns to Which Chinese MPL platforms will emerge from consolidation. Sign up to get our daily research delivered by email so you don’t miss this (link on top right of this site).

 

Daily Fintech Advisers provides strategic consulting to organizations with business and investment interests in Fintech & operates the Fintech Genome P2P Knowledge platform.

 

Takeaways from #LenditEurope: watch while the next phase unfolds!

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The weather was beautiful in London, the location was upcoming (O2 North Greenwich) and the size of the conference was ideal. The two chairs, Peter Renton (founder of Lendit) and Christine Farnish (chair of P2PFA) were both great on stage as they covered an industry that has been tainted in 2016 and that has clearly lost its hype.

I gathered lots of insights from the sessions and from talking to attendees. I share here some highlights and look forward to continuing publicly the conversations that these insights open up, on the Fintech Genome.

THE SECTOR IS READY FOR THE GOLDEN AGE:

  • Samir Desai, cofounder of Funding Circle, shared his vision in a nutshell:
    • “The Golden Age is in sight in marketplace lending” as the disruption through capital light business models spreads everywhere.
  • Neil Rimer, co-founder at Index Ventures (early investor in Funding Circle)
    • You have to be in a market, the lending market, that has a trillion-dollar addressable audience; We are entering into the golden age of this new asset class.
  • Phin Upham, from Thiel Capital, said:
    • If you are looking to raise money, go into Insurance. The hype is gone in the US lending market, so it is very difficult to raise equity.
  • Platforms are entering into another phase; they are forced to innovate continuously and to scale either geographically or in terms of the loan type.

THE INDUSTRY NEEDS LOTS OF EDUCATION AND UNDERSTANDING: The P2PFA which was co-hosting the conference, was not the only one, to repeatedly address the issue of misunderstanding of “What is this business all about?”

  • Is it non-bank lending, which has been around forever.
  • Is it unregulated bank lending, which will eventually lead to these platforms seeking or having to get a bank license?
  • Are platforms simple originators for banks? Or matchmaking platforms? Or Tech platforms?
  • Is this a new asset class?
  • Is crowdfunding like direct online lending?

Engage in this open conversation here.

A NON-STANDARDIZED MARKETPLACE (a separate post will be dedicated on this topic):

  • Borrowers – There is a large variety of loans. First, we categorize them in unsecured and asset-backed. Second, we have to distinguish by asset and maturity: consumer loans, auto loans, property, small business, working capital, invoice finance etc.
  • Lenders – From the investor’s side, we have retail, government, private funds, asset managers, institutional investors. Each class needs-requires a different wrapper. From direct loans, whole loans, private funds, private bonds backed by loans in SPVs, BDCs, listed funds, securitized deals.
  • The incentives for Financial advisors to step into this new asset class; are problematic.

THE INDUSTRY DISAGREES ABOUT THE BUSINESS MODEL: Engage in this open conversation here. Is the business model:

  • Pure P2P platforms offering efficient intermediation between borrower and lender; with no inventory on the platform (e.g. RateSetter for consumer loans and Funding Circle for smallbiz loans)
  • Using your balance sheet; Efficient servicing for borrowers; with a platform that has an inventory (a la Kabbage and LendInvest).
  • Hybrid lending platforms.

RateSetter and Funding Circle, are strong advocates Against the hybrid model. The ecosystem can’t agree on One name, P2P, Market place Lending, Online Direct Lending!

NO AGENCY PROBLEM IN THE CREDIT ASSESMENT PROCESS: P2PFA commissioned report from economic research firm Oxera that focuses on consumer issues, risks towards designing an effective public policy. This is strictly based on facts and figures from the 8 members of the P2PFA which account for ¾ of the UK market. And even though, some said “please stop measuring success with origination volume”; this remains the metric for now. The Oxera report can be downloaded here. The most interesting question addressed is “Do marketplace lending platforms have the incentive to do effective credit risk assessment (since they don’t allocate their own capital but “other people’s money” and they earn the spread – which is around 4%)”? The answer is positive.

THE LENDING SECTOR DOESN’T POSE SYSTEMIC RISK: Lord Adair Turner, from the Institute for New Economic Thinking and author of the book “Between Debt and the Devil”, highlighted

  • The fact that non-bank lending has traditionally been an important part of the economy.
  • The fact that MPL platforms aren’t employing any radical credit analysis; they are simply executing conventional processes, in a “better” way.
  • His conclusion was that the way to avoid a future blowup, is to keep the products and their distribution Simple & Transparent. Watch his speech here.

LENDING SECTOR SENTIMENT:

  • Public stock prices have been telling us in 2016 that the expectations of the sector were unrealistic.
  • UK listed investment trusts, are trading at deep discounts (15%) and the share prices have struggled since IPO. This IMHO is because they are complicated structures and therefore misunderstood. As they admitted (panel participation), they do need to become more transparent. For now, they will be buying back shares to try and close the discount gap.
  • Credit spreads have widened in the US and the CHAI securitization deals is on watch from Moody’s. Deals are forced to offer increased coupons and wider spreads. At the same time, in the US the new securitized deals see tightening in the secondary market. In addition, the securitization volume overall has been increasing despite decreasing origination volume.
  • Of course, on stage we heard that the recovery will come and there has never been a better time to switch from equities into P2P. This I find too strong a statement. Switching from other fixed income asset classes into P2P, is they way to go.

A FEW MORE INSIGHTS

  • I suggest monitoring: Zopa which is the oldest of them all, operating from 2005. And Sofi in the US, because it has been remarkably resilient in the 2016 difficult environment for MPLs (See conversation here for a full list of possible factors and to engage).
    • Sofi raised $1bil before LC accident
    • They have been trying tons of new thing, while everybody else is cutting costs, they have launched 3 new products already this year.
  • The consistency in the pipeline of securitization deals in Europe, needs to pick up. Follow the SOFI lead is the way to go.
  • Be aware that after the Brexit vote; the engagement metrics on the UK platforms surged both on the consumer loan and on the property backed lending platforms.
  • I suggest that you always check the Provision fund on any platform you consider engaging. The amount is important but pay attention to “how” it allocates in case of defaults (you wont to know the pecking order).
  • Most platforms take their fees upfront; some are now taking out the fees through the life of the loan (e.g. RateSetter). Always a win for the customers.
  • The Baltic have a significant presence in the Lending category. Twino, Bondora, Finbee, Mintos.

LENDIT

“Lendit” is echoing in my head. I actually think it is a brilliant name choice for this sector because it seems to me very Agile (if you happen to disagree, engage here). Today “IT” means (to most people) lending your uninvited cash to another person or company; and earning of course, interest. Tomorrow “IT” may also mean, lending securities (much like repos or shorting). Later “IT” may grow into, lending your digital assets (much like in acting as a guarantor, effectively lending out your creditworthiness).

  • In the sharing economy, “Lendit” fits in naturally.
  • “LendIt” speaks to the inertia of uninvested wealth.
  • More women around and on stage are needed for next year.
  • There was a hint about the need to focus and imporve the analytics and use ML; but more coverage of this area is needed.
  • I am sure that next year there will be a more balanced mix of those involved in the ecosystem. More Spain, Germany and France. More banks that are involved in the direct online lending space. More about radical innovations in the lending sector.

The conversations continue on the Fintech Genome in the Lending category. This is a snapshot of the existing ones. Engage.

 

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Daily Fintech Advisers provides strategic consulting to organizations with business and investment interests in Fintech & operates the Fintech Genome P2P Knowledge Network.  Efi Pylarinou is a Digital Wealth Management thought leader.

4 Scenarios for Lending Club – the proxy for Fintech disruption or hype $LC

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When Lending Club did it’s IPO in December 2014 I declared it as the Netscape moment for Fintech (when it became conventional wisdom that this was going to change the world). I could be accused of contributing to the Fintech hype, which became intense in 2015 with investors flooding into Fintech ventures. Meanwhile the $LC stock price tanked to such a level that by late May 2016, after the Lending Club CEO ouster, the conventional wisdom became that yes this was the Netscape moment for Fintech and we all know how the Netscape story ended – they were crushed by Microsoft.

That is one of the 4 scenarios that we analyze in this post – that incumbency wins, that big banks crush Lending Club and that Marketplace Lending becomes a footnote in banking history. In that ending, George Foreman beats Muhammad Ali in Rumble in the Jungle.  Conventional wisdom expected that George Foreman would win. But that is only one of 4 scenarios that we analyse.

Disclosure: I bought some Lending Club stock after writing this post in May (I was fortunate enough to get in at 3.51). In two of my 4 scenarios that was a dumb move. However, spoiler alert, my analysis is that one of the other two scenarios is more likely.

4 Scenarios

# 1 Like Netscape getting crushed by Microsoft, Lending Club will be crushed by big banks.

How this would play out. Banks refuse to lend to borrowers via Lending Club, so they will be dependent on retail lenders (which is only one of three lender channels that Efi Pylarinou analyses in this post and not enough to fuel rapid growth).

Evidence that this is true. After the problems that led to the Lending Club Board firing the Founder CEO, banks put a hold on lending via Lending Club (and other MarketPlace Lenders). Given the old world disclosure problems analysed by Efi Pylarinou in this post, it would have been amazing if banks had not put a hold on this while they did extra due diligence.

What will happen to Lending Club stock in this scenario? A big bank buys them for a firesale price to get access to technology and talent. There will be competition from multiple big banks, so a competent investment banker should extract a reasonable price, but there won’t be any champagne corks popping among Lending Club shareholders in this scenario.

What will happen to other MarketPlace Lenders in this scenario? They will also be acquired for firesale prices and nobody will back another MarketPlace Lending venture. It will be game over.

Likelihood rating: Least Likely.Conventional wisdom currently favours this scenario, yet I rate it as Least Likely (the next scenario is even worse for Lending Club shareholders and a bit more likely). The reason I rate this conventional wisdom as Least Likely is that it is based on a fundamental misunderstanding. Banks don’t own this money. it is a Liability on their Balance Sheet because when we Deposit money with a Bank, we are lending money to a bank. When we wire money to a Credit Hedge Fund, we are lending them the money in the hope that they will return it with profit later.  Banks and Hedge Funds are intermediaries just like Lending Club is an intermediary. So if the real investors (you and I and richer versions of you and I) decide we get a better risk adjusted return by lending via Lending Club than by lending to a bank or Credit Hedge Fund, then that is what we will do (for some more on this idea, read this post).  For some insight on how this could happen, read Jessica Ellerm’s brilliant post on how Fintech innovation may finally be coming to the deposit part of banking.

Note: even Least Likely is a possible scenario. We can declare this scenario Totally Unlikely if and when the Jeffries securitization deal that was put on hold during the disclosure problems finally closes. (I put Goldmans in a different category because they clearly have their own ambitions in marketplace lending).

# 2 The first “run on a marketplace”.

Like a run on a bank, when trust goes, it goes fast and leads to panic. This is “reverse network effects”. We have seen a run on a bank many times before in the past. A “run on a marketplace” would be unprecedented, but these times are different.

How this would play out. Lenders cannot withdraw their money (as bank depositors can) so it is not exactly like a run on a bank, but lenders can refuse to lend any new money and that will have the same fundamental effect. In a vicious cycle, retail lenders and equity investors get scared away, leading to more bad news, leading to… In this scenario, I worry less about what a few bankers think (Scenario #1), but I worry about what millions of consumers (retail lenders and equity investors) think.

Evidence that this is true. Just look at the $LC stock price.

What will happen to Lending Club stock in this scenario? Not even a firesale buyout, total loss.

What will happen to other MarketPlace Lenders in this scenario? One may prove reliable enough and emerge triumphant in a Rocky like “last man standing” result. But that is a very slim chance. More likely is the same as Scenario # 1.

Likelihood rating: Unlikely. Calm voices who look at the actual returns of retail investors such as the ever insightful Peter Renton at Lend Academy show that the risk adjusted returns are good. Individual retail lenders tell a similar story. The panic at the moment seems restricted to the media and this sort of hype/despair cycle is normal. The Lending Club Board clearly understands the issue and that is why they took decisive action in May.

# 3 Like Priceline, the stock will bounce along the floor for years and then return 100x for really patient investors.

Management slowly get past all the serious execution challenges and, because digitisation is unstoppable and digitisation means that marketplaces and networks always win in the end, the eventually upside is stunning. That is what actually happened to Priceline (no, not a measly 10 bagger but a “10x 10 bagger” aka 100x return).

How this would play out. Scott Sanborn and his team get the Board’s backing to patiently execute on their plan. There are two big execution challenges:

  • Employee stock options are under water. They either face a talent drain or issue new options that hurt common shareholders. Both choices are ugly.
  • The growth is outside America, but going for that growth will be expensive.

This will be difficult. Their Q2 results are likely to be ugly. There will be lots of setbacks and bad news cycles. That is why the stock will bounce along the floor for years (and years is a long time when day traders are considered long term investors compared to HFT).

Evidence that this is true. Hiring a credible Chief Capital Officer. In this scenario, it takes years to execute on a recovery plan, so yes that is only one of many results that the management team needs to deliver on.

What will happen to Lending Club stock in this scenario? For most investors, who give up during the years when it bounces along the floor, a loss. For a tiny number who stick with it (based on conviction or just forgetting they own the stock), a massive return.

What will happen to other MarketPlace Lenders in this scenario? Few will have the patience to execute like this and will take acquisition offers, making the last man standing even more valuable.

Likelihood rating: Possible. I am not an insider. I have no idea what is going on inside the Lending Club Board. However I do know that a) these are solvable execution challenges with a lot of patience and hard work and b) Boards are typically not very patient these days and so while this is Possible, I think the next Scenario is more likely. Also I think the value of MarketPlace Lending (which will be massive) will get distributed across an ecosystem rather than sticking to only one or two Facebook style behemoths.

# 4 Buyout, probably from a Chinese company.

How this would play out. The Lending Club Board accepts an offer.

Evidence that this is true. None, there won’t be evidence until the Lending Club Board accepts an offer, but we do know that one Chinese investor bought after the stock crashed and now owns over 11%.

What will happen to Lending Club stock in this scenario? Some premium to the market price at the time of offer.

What will happen to other MarketPlace Lenders in this scenario? Investment bankers representing them have their phones ringing off the hook.

Likelihood rating: Likely. Not only do we already see a big Chinese investor in the company, the business logic is impeccable:

  • To be a big player, Lending Club has to get into China, which is a huge market but very difficult to get into without a) deep pockets b) local partners.
  • China is a huge market for consumer loans but none of the MarketPlace Lenders in China has the organisational strength and technology of Lending Club (or Prosper or SOFI or Funding Circle).

Combine huge market and good platform and you get a great result.

Note on Scenario Ratings. I only have 5 – Totally Unlikely, Least Likely, Unlikely, Possible, Likely. I don’t try to put % numbers on this as that gives a false sense of certainty. I am looking at this as an investor and the end result for an investor is binary – profit or loss. Even a Least Likely scenario could come to pass and investors simply have to a) have confidence in their analysis and b) enough diversification to not be “weak hands” that are shaken out by a negative news cycle that drives trading sentiment and drops the share price temporarily.

Personal Note. Like most people, I love a triumph over adversity story such as Muhammed Ali in Rumble in the Jungle but my personal sport is skiing and the triumph over adversity story that I love is Franz Klammer’s comeback in 1984 as an “old man” of 30 on his home run – the Hahnenkamm.   Watching at the time, I hoped he would win but thought it Totally Unlikely.

There are two types of Fintech innovation. One type of Fintech innovation says to Banks “we bring you lunch”. It is a variant of traditional Fintech where the venture prices on a transactional revenue share basis instead of via a traditional software licensing model.

The other type of Fintech innovation says to Banks “we eat your lunch”. It is disruptive and the potential and risk for backing this type of venture is much higher. The fate of Lending Club is a bellwether for this latter type of disruptive Fintech innovation. How it prospers or fails will impact the broader sentiment about whether disruptive “we eat your lunch” Fintech innovation is viable.

Daily Fintech Advisers provides strategic consulting to organizations with business and investment interests in Fintech & operates the Fintech Genome P2P Knowledge Network. Bernard Lunn is a Fintech thought-leader.